A common query we encounter is investors looking to opt for a 1031 Exchange within the family. In this blog, we will explore the details around a related party exchange.
Related Party Exchange Basics
When a taxpayer attempts a 1031 exchange with an entity or party which is related under US tax code, the process is referred to as a related party exchange. This includes ancestors, siblings, spouses, and direct lineal descendants, per Sections 267(b) and 707(b) of Internal Revenue Code, and it also includes any partnership or corporation in which you own at least 50 percent interest.
Related Party Swaps
If you relinquish your property to a related party, then acquire your replacement property from that same related party, the swap will be permitted – if both the parties hold the acquired properties for a minimum of two years after the final exchange transfer. If either party transfers the property before two years, the exchange will be immediately disqualified and both the parties will need to pay taxes.
Related Party Sales
While doing an exchange with a related party, the involvement of an intermediary is a must. Both IRS code and court rulings affirm that using intermediaries will not remove any restrictions on such exchanges, however – in the past, many investors attempted the same.
This doesn’t mean that you can no longer do this exchange, you just need to ensure that the related party maintains holding of the new property for at least two years. There are also a few exceptions which we will discuss below.
Related Party Purchases
Mostly, IRS or courts do not permit exchanges where you purchase from a related party and sell to an unrelated party using an intermediary. There are few exceptions such as – when the related party is also attempting an exchange with their own unrelated party.
There are many exceptions to be considered –
Death:Parties are permitted to dispose of properties prior to the two-year holding period if either the related party or the taxpayer dies during this period.
Involuntary conversion: If either property is subject to involuntary conversion during the two-year holding period, the parties will avoid being taxed.
Not for avoidance:If it can be established that your primary purpose is not to avoid Federal income tax, trading with related parties will be allowed. This is also called the non-tax avoidance exception,” which our advisors can explain better.
Related party exchanges can be a bit tricky; you should seek expert guidance to ensure the process goes smoothly. Speak to our advisors at 888-993-2835 or email us at firstname.lastname@example.org.